Erstwhile mechanical engineer and Forbes Executive Editor, with MBA from NYU. In 15 years at Forbes I covered large corporations, money managers and self-made wealth builders---and the myriad trials they all face. Joined the tech-startup ranks in 2014 as co-founder and CFO of Eyes/Only, a luxury-experience portal for high-net-worth individuals. If the mood strikes (and especially if you have a tasty-tequila rec), please send your thoughts to brett@eyeson.ly.

The Biggest Financial Story In America--For Years To Come

In mid-2010, as the economic recovery began to show its true anemic color, I bemoaned America’s grasp of basic financial matters (see: Financial Illiteracy Is Killing Us). The article contained a bunch of arresting statistics, but there’s one number that makes all the recent squawking about the $600 billion fiscal cliff—and every other headline-grabbing issue, for that matter—beside the point.

That number is $87 trillion, and it is the present value of America’s future financial obligations—in plain English, what the country owes and, as things stand, cannot remotely hope to pay.

The trouble with big numbers is that too many zeroes blur into abstraction. Yet—as Chris Cox, former chairman of the Securities and Exchange Commission, and Bill Archer, senior policy adviser at PricewaterhouseCoopers, recently drilled home in an article in the Wall Street Journal—that $87 trillion represents a burden as real as oxygen and gravity. When numbers get this big, they affect you, your kids, their kids and even their kids.

Truth told, this story should be front-page news for the next five years—or at least until we all truly come to grips with it.

To understand why, you need to understand one simple yet wonky-sounding financial concept. From there, the rest will go right into the bloodstream (and quickly bring it to a boil).

The concept is called an “unfunded liability,” which is simply an amount owed in the future for which there are no savings or investments set aside to cover it.

Example: Say you generously promised to buy your daughter a car after she graduated from college. You’re not in the 1% club, so you have to sock away for a few years. You might even consider investing a chunk of money in the hope that it will grow enough to cover the amount needed to pay for the car down the road. If the markets behave and it appears you’ll make good on your promise, your liability is “funded.” If it appears you’ll fall short, your liability is “unfunded.”

There are lots of reasons for falling short. Say you thought you’d earn a higher return on that car fund. Happens all the time—just ask the sharp-penciled pension-fund managers who invest on behalf of retired policemen, firefighters, teachers and sanitation workers. At last count, the total unfunded portion of all U.S. public pension liabilities ranges from $730 billion to $4.4 trillion. Dial back the expected rate of return on those investments by a percentage point or two and those numbers explode even bigger.

Who do you think will ultimately have to eat the tab? Starting to care a little more about this stuff?

Now for that $87 trillion Cox and Archer are talking about.

The U.S. debt is often reported as $16 trillion—about equal to the country’s annual gross domestic product (GDP). In other words, debt is now 100% of GDP. By historical standards, that ratio of debt-to-GDP is extremely high: The last time America’s debt surpassed annual GDP the country was girding for World War II.

But that $16 trillion tells only a small part of the story. As the authors note: “The actual liabilities of the federal government—including Social Security, Medicare, and federal employees’ future retirement benefits—already exceed $86.8 trillion, or 550% of GDP.”

The technical answer for this staggering discrepancy is that, while the U.S. Treasury Department lists trillions of dollars worth of liabilities on its balance sheet for all to see, it fails to include various unfunded liabilities—such as those related to so-called entitlement programs like Medicare and Social Security.

And those unfunded liabilities are a tad larger than the shortfall on your daughter’s car.

According to the most recent Medicare Trustees’ annual report, in April, Cox and Archer write, “the [current] value of the unfunded liability of Medicare was $42.8 trillion. The comparable balance sheet liability for Social Security is $20.5 trillion.” In short, that means: “Borrowing on this scale…could bankrupt not only the programs themselves but the entire federal government.”

Cox and Archer aptly put the numbers in the context of the current philosophical standoff on tax policy: When the amounts that theoretically must be set aside every year to cover future payouts to entitlement programs are tallied, it becomes clear that “to collect enough tax revenue just to avoid going deeper into debt would require over $8 trillion in tax collections annually.”

Where to find $8 trillion? Taxes alone won’t get us there—not even close.

Consider, the authors continue: “All individuals filing tax returns in America and earning more than $66,193 per year have a total adjusted gross income of $5.1 trillion. In 2006, when corporate taxable income peaked before the recession, all corporations in the U.S. had total income for tax purposes of $1.6 trillion.”

Translation: If you confiscate all the earnings of people who make above $66,000 a year, plus all of the corporate taxable income at the height of an economic bubble, the U.S. is still shy $1.3 trillion per year to fund the growth of its future obligations.

Put another way, conclude Cox and Archer: Filling our fiscal hole by taxing all taxpayers, let alone just the upper crust, amounts to “bailing out the Pacific Ocean with a teaspoon.”

Think about that. No, really, think about it.

Hopefully, when everyone’s done thinking, we’ll have enough time left to act.

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Brilliant stuff that even a number-phobic shrink like me can get his arms around. Just one question: Why stop short of saying that all the “reaching across the aisle” posturing going on in D.C. at the moment is useless, and that unless Congress finds about 800 sets of cojones that they’ll need to cut entitlements in major ways, we’re headed to the same fate European socialists are suffering?

I feel that the average everyday “Joe” is having enough trouble understanding the term “Fiscal Cliff” let alone able to wrap their heads around this massive issue. It never ceases to amaze me how a “smaller” issue can somehow dwarf the larger issue in the media. So is there any real way out of this mess?

Very good article. It is indeed sad and scary that we are in this situation, and there is so much blindness and ignorance. The article here paints a very dire, and unfortunately very real picture of what is going on… however, for the next article – how about some actual solutions? Since we all can’t give up all of our collective incomes, and slashing the “entitlements” to bare minimum will be painful to a potentially riotous extent, what can honestly realistically done, short and long term? Lastly, an honest non-political article that clearly explains HOW we got into this mess would be quite helpful… maybe a three part series: the How We Got Here, the What It Means To Be Here (similar to this article), and then the How In The Hades Do We Correct This Damn Mess (some options, with the least to the most amount of pain). BTW, graphs depicting the various historical aspects, how our current situation compares to other countries, etc. are all very helpful. Again, good article… more! :)

Mr. Nelson, thank you for a great article. I wonder why lots of editorialists frame the problem so well, and then hold back on recommendeding solutions? It is true that the main culprits are clearly identified in your article (you could probably even add our operations in Afganistan – gasp). I also realize that any proposed solution is going to be necessarily painful (and possibly biased)…but it seems no one will propose ripping off the band-aid.

The flaw in this thinking is the myth that transfer programs like Social Security and Medicare are like annuity or pension funds. They’re not. They are income transfer programs. Social Security, for example, it is paid by a dedicated payroll tax. If the payroll tax is insufficient to pay benefits, the govt can allocate money from the general fund, or raise the payroll tax, or cut benefits. There is no need to “set aside” money for Social Security at all. The Social Security Trust Fund, which is the basis for the “unfunded liability” scare story, is an accounting fiction. It is a collection of govt. bonds, which gives SS payouts the same status as other debt. And, of course, it is a Treasury piggy bank paid for by a flat tax. There is no unfunded liability at all. But if you want to continue adding up scary numbers, calculate our “unfunded liability” for the Defense Department. How much do we have to “set aside” in order to meet future defense needs?

Thanks for reading, dallas. Accounting formalities aside, I think your assertion—”If the payroll tax is insufficient to pay benefits, the govt can allocate money from the general fund, or raise the payroll tax, or cut benefits”—is way too sanguine.

Let’s start by reverting to the “Defense Department’s” original name … The “War Department”. No one wants to cut back on DEFENSE, but I’ll bet we can get a lot more agreement on cuts to our OFFENSIVE capabilities.